Oil Slump Concerns Overplayed in Gulf Stock Markets?

The price of oil suffered its biggest drop in nearly two years earlier this week after the International Energy Agency reduced its forecast for demand for this year and next.

Associated Press

A slump in oil prices has eroded investor confidence in Persian Gulf stock markets, some of which are among the leading performers globally this year.

The major oil-exporting states in the region such as Saudi Arabia, Qatar and the U.A.E. use the hundreds of billions of dollars in revenues from hydrocarbon sales to boost their economies: the concern obviously is that plunging crude prices will drastically limit their ability to continue investing in, and driving local growth.

Not surprisingly, most regional markets tumbled on opening Sunday after a long religious break last week as investors also caught up with a sharp deterioration in global risk environment on growth concerns.

Saudi, the Middle East’s biggest market, and Dubai, which is leading the regional rally this year so far, fell nearly 7% to wipe out tens of billions of dollars in market capitalisation. The markets have since been volatile, reflecting investor uncertainty.

While the basic premise holds true, many believe that such fears–of weaker oil hurting local economies–are premature and currently overplayed.

For one, analysts point out that even when oil prices plumbed lows of $34/bbl and averaged $60/bbl in 2009 – most Gulf states not only generated comfortable current account surpluses, they also continued to build cash cushions and pay down debt.

“It is also easy to be carried away by spot prices and the near-term volatility when the really important measure is the average price over a period, particularly when the oil price has tracked well above budget break-evens,” Eclectic Strategy’s Emad Mostaque said.

The last three years have seen oil prices averaging around $110/bbl; and we would need to see almost a year of oil at $80/bbl before the moving average dipped below $90/bbl, he noted.

Besides, Gulf States have been saving excess profits for any future dips, which makes recent panic over spot prices even more puzzling, Mr. Mostaque told clients in a note this week.

And given the regional unrest, governments will likely continue to spend locally–even if oil prices drop well below budget levels–to help placate their populations.

This doesn’t mean that the region’s stock markets didn’t need to correct.

“Regional markets have enjoyed a strong run over the past couple of years and some profit-taking was due,” said Fahd Iqbal, the head of Middle East research at Credit Suisse.

In that sense, the selloff in global equity and oil markets last week was just the trigger.

EFG Hermes in a note to clients this week said Saudi Arabia is trading at its biggest premium to emerging markets since late 2006. “On the last two occasions that KSA equities traded at these multiples – in 2010 and 2008 – subsequent 12-month price returns were negative,” the analysts noted.

The valuation story is pretty much the same across several regional markets after some solid gains since early 2013. Despite the recent bout of selling, Dubai shares are still up 33% this year after doubling in value in 2013. And Saudi stocks are up some 17% this year.

Credit Suisse’s Mr. Iqbal said they view regional market weakness as an opportunity to accumulate exposure in select quality names.

What most analysts do agree on is adopting caution in the short term. As Shuaa Capital warned: “Do not take the drop in oil prices lightly as it could have a much bigger impact on the Saudi market [and the region] than what we have already seen.”